Ponzi Scheme

What is a Ponzi Scheme?

To explain it in the simplest words, it is “21 din main paisa double”. It is an investing scam that promises to generate returns to users from the investment of newer users. It does not have any business activity from which it can earn a profit. All it does is circulate money until it’s busted. It seems very easy to spot one but they are present everywhere and the conmen are becoming quite adept at hiding them. 

How did it start?

Charles Ponzi scammed so hard his surname became the name of this infamous technique. Arriving in America with nothing to his name he tried some illegal ways to earn money before he found a loophole in the system. 

He realised stamps purchased in Spain could be sold for a higher value in America due to the difference in Forex as the value of the Peseta had fallen against the American Dollar. Was he satisfied with his neat little discovery to make a comfortable living? No. He asked investors for investment to carry on his plan at a grand scale. He asked people to invest his “business” and promised a return of 50% interest in 90 days! Investors ran and begged him to take their funds. And take their funds he did, seeing himself flush with cash he carried on paying old investors with the cash influx of the new investors. 

Until his scam was caught, as the rate at which he was borrowing was unfathomable. At this peak he was borrowing $1 million a day ($13 million adjusted for inflation). He scammed people worth $20 million in 1920. Simply calculating interest it is worth $260 million today. 

The Big Daddy Of Ponzi Schemes

Bernie Madoff. A scam worth $64.8 billion. In 2009! The second biggest scam in the world was a Ponzi! 

He collected money from investors. They kept their investments with him for decades in most cases. He sent them statements showing what trades he made that month and how much money they made from them. But the trades were all a lie. He had a guy who’s full time job was to look up stocks trading ranges and make fake investment reports to send out every month. Because his investors tended to be very wealthy, very few attempted to withdraw money, and he was able to show they were making “profits”. The 2008 stock market crash. Ponzi schemes work only as long as the scammer keeps getting more investments. Once investors start to pull out, it turns out there isn’t enough money and the scheme collapses. During the market crash a lot of people pulled out their investments to avoid losing more money, which resulted in exposing the scheme as there was not enough money to pay out investors

He desperately tried to find new investors so that he could pay the people who wanted their cash, but of course, at that time, no one was investing in anything. So he had to confess and say that he was unable to pay them back. It is a very strange case, because he didn’t spend the money he got from them, he just put it in the bank. But he sent out reports showing people they were earning 10% a year and their accounts were growing when they were not. Some banks became suspicious, because he wasn’t moving money around like a guy investing billions normally would. So he just moved money around from various accounts to try to make it look reasonable. No one called him out because he was a very well respected financial guy.

How did he manage to hide it for so long?

  • Madoff was a well-versed and active member of the financial industry
  • He sat on the board of National Association of Securities Dealers
  • Advisor of the Security Exchange Commision
  • He had wealthy clients so access to large amounts of cash
  • Accounting books audited by a 2 person private firm. (Friehling & Horowitz)

In fact his own sons who were involved in the business were not aware of his wrong doings until it was exposed. One of his sons committed suicide after learning about it.

Right now he is serving a 150 Year sentence in maximum security.

He knew the rules well so he broke them with ease.

How to spot a Ponzi scam?

  • Exorbitant returns
  • Schemes not registered with authorities
  • Returns mostly remain constant
  • Providing no valid documentation
  • Complicated strategy
  • Unauthorized intermediary
  • Difficulty in receiving payments

If it is too good to be true, it is too good to be true.

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